Tuesday, 22 January 2013

The Entrepreneur, the Manager and Excessive Risk Taking

In his book Human Action: A Treatise on Economics (p. 303), Ludwig von Mises writes the following about the difference between the entrepreneur and the manager (my bold),
Society can freely leave the care for the best possible employment of capital goods to their owners. In embarking upon definite projects these owners expose their own property, wealth, and social position. They are even more interested in the success of their entrepreneurial activities than is society as a whole. For society as a whole the squandering of capital invested in a definite project means only the loss of a small part of its total funds; for the owner it means much more, for the most part the loss of his total fortune. But if a manager is given a completely free band, things are different. He speculates in risking other people's money. He sees the prospects of an uncertain enterprise from another angle than that of the man who is answerable for the losses. It is precisely when he is rewarded by a share of the profits that he becomes foolhardy because he does not share in the losses too.
Mises words fit in nicely with the running and structure of large U.S. investment banks, pre and post the 2008/2009 "financial crisis" - the "managers" are in charge and their potential gains from ownership in the business is too small (and hence exposure to losses is too small) compared to the potential annual bonus (profit sharing).

 

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